[Original article also contains interactive map of what happens when U.S. defaults.–CB]
What it is: The debt ceiling is a legal cap on the amount of money the Treasury can borrow to fund existing government functions. It essentially authorizes the Treasury to borrow the money necessary to pay the bills incurred by the federal government.
Where it came from: Before 1917, Congress authorized the Treasury to issue bonds for specific purposes. But that meant approving every bond separately. To fund World War I, Congress decided to give the Treasury more latitude by instituting caps on how much it could borrow through each type of bond, rather than forcing it to get every new bond approved separately. In 1939, this was changed so that most bonds were bound by the same limit, effectively creating the general debt ceiling we have today.
How has it worked? The debt ceiling has traditionally been raised as a matter of course whenever Congress passes spending bills requiring more borrowing, though the opposition party has often voted against increases to signal its opposition to the majority’s deficit spending. Between 1940 and 2010, we have increased the debt limit more than 70 times, and from 1979 to 1995, a House rule proposed by Rep. Richard Gephardt made increases automatic by raising the ceiling whenever new spending is approved. The new Republican majority repealed this rule in 1995 in order to use raising the debt ceiling as leverage in getting President Clinton to agree to spending cuts.
Why it’s an issue now: Currently, the debt limit is set at $14.3 trillion. Around Aug. 2, the Treasury will exhaust that borrowing authority. Because spending currently exceeds revenues by almost 45 percent, if that happens, we will either have to default on our debt or stop funding a substantial portion of the government. Congress could simply choose to raise the debt ceiling, but like the 1995 House GOP, the 2011 House GOP is insisting that it will not increase the debt ceiling without large spending cuts from President Obama.
What happens if we don’t raise the debt ceiling but continue to pay interest on our bonds? This is an option known as “prioritization.” The Bipartisan Policy Center released a report attempting to think through how this would work in practice, as it has never been attempted before. The raw numbers are chilling: In August, the federal government would have to cut expenditures by about $134 billion, or 10 percent of the month’s GDP. If it chose, for instance, to fund Medicare, Medicaid, Social Security, supplies for the troops and interest on our bonds, it would have to stop funding every other part of the federal government. The drop in demand, when coupled with the turmoil in the markets and the general financial uncertainty, would undoubtedly throw the economy back into a recession. Also keep in mind that we have to roll over $500 billion in debt that month, and if there was uncertainty about how we were going to pay our bills, it is not clear we could find buyers for our debt at anything less than an exorbitant rate. In this way, “prioritization” could actually increase the deficit.
What happens if we stop paying the interest on our debt? This is too scary to consider for any serious length of time. Treasury securities sit at the base of the global financial system. They are considered so safe that the interest rate on Treasuries is called the “riskless rate of return,” as the market assumes there is no chance of default under any circumstances. Almost all other types of debt — mortgages, credit card, auto loans, business loans, hospital bonds, etc. — are yoked to Treasuries. Almost all major financial players hold substantial portfolios of Treasuries or Treasury-related debt in order to buffer themselves against financial shocks. Consider that the 2007 financial crisis was caused by the market realizing it had to reassess the risk of bonds based on subprime mortgages. If the market has to reassess the risk of Treasuries, the resulting financial crisis will be beyond anything we’ve ever seen in this country.
Do we need a debt ceiling? Strictly speaking, no. The debt ceiling is unique to America. In other countries, when the legislature passes a law, the Treasury is given automatic authority to carry it out. A number of former Treasury Secretaries have said it should be abolished, including Larry Summers, who said, “I think that given that Congress has to approve all spending and all tax changes, there is not much logic to the debt ceiling.”
Does the debt ceiling reduce deficits? In general, no. The nonpartisan Congressional Budget Office examined this issue and concluded (pdf) that “setting a limit on the debt is an ineffective means of controlling deficits because the decisions that necessitate borrowing are made through other legislative actions. By the time an increase in the debt ceiling comes up for approval, it is too late to avoid paying the government’s pending bills without incurring serious negative consequences.”
Is the debt ceiling unconstitutional? A number of commentators have suggested that the 14th Amendment, which states that “the validity of the public debt of the United States … shall not be questioned,” renders the debt ceiling unconstitutional. Others have disagreed, including Lawrence Tribe, a professor of constitutional law at Harvard, who notes that the Constitution gives Congress the sole power “to borrow money on the credit of the United States.” Ultimately, this point is probably moot, at least for the time being, as the Treasury Department has stated that it agrees with Professor Tribe’s interpretation.
What are the deals that Congress is considering in order to raise the debt limit, and could you rank them from most-to-least likely?
* McConnell and McConnell-Reid: Senate Minority Leader Mitch McConnell proposed giving Obama the unilateral power to increase the debt ceiling, with Congress capable of blocking him if it passed and overrode his veto on resolutions condemning the increase in the limit. The idea would be to force Democrats to vote repeatedly in favor of increasing the debt ceiling, while allowing House Republicans to vote against it without forcing the U.S. to prioritize programs or default. House Republicans rejected this as a giveaway to the administration, so to make it more palatable to them McConnell and Senate Majority Leader Harry Reid have been working on attaching $1.5 trillion in spending cuts and an expedited congressional process for approving them to the plan.
* A big deal: In negotiations with congressional Republicans, Obama pushed for a deal to cut the deficit by $4 trillion over 10 years through a combination of discretionary cuts, changes to entitlements such as Social Security and Medicare, and revenue increases achieved through cutting tax breaks. Specific options considered as part of this plan included an increase in the Medicare retirement age, reducing the rate of growth for Social Security benefits, and cuts to the employer health care tax deduction. House Speaker John Boehner and Majority Leader Eric Cantor rejected the big deal, but it appears to be making a comeback.
* A small deal: Negotiations between the administration and congressional Republicans uncovered between $1 trillion and $2 trillion in spending cuts that both the Democrats and the Republicans could accept. The Democrats would like to see these spending cuts accompanied by new revenues, but there have been some intimations that the Obama administration could accept a deal with $1.5 trillion in spending cuts and no new revenues. The most specific look we’ve gotten at these cuts came in a slideshow presented by Eric Cantor and leaked to the press.
* A clean debt limit increase: For the first few months of negotiations, the White House stated that it wanted a “clean” debt limit increase, not paired with any spending cuts or rule changes. When it became clear Congress would not vote for this, the administration abandoned the call and started working out a deal. On May 31, the House voted overwhelmingly against a clean debt limit increase, in an attempt by House Republicans to get Democrats on record supporting it. You can argue, however, that McConnell’s proposal is essential a clean increase.
* Cut, Cap, Balance: Rep. Jason Chaffetz introduced a bill, backed by the House Republican leadership, called “Cut, Cap, and Balance,” which would increase the debt ceiling in exchange for $111 billion in immediate cuts next year, statutory caps on spending, and a balanced budget amendment to the Constitution that includes a spending cap of 18 percent of the previous year’s GDP and would require supermajorities to raise taxes or increase the debt ceiling. If the amendment was ratified, spending would have to drop to its lowest levels since the 1950s — despite the fact that we now have Medicare, Medicaid, more seniors, etc. — and taxes would be almost impossible to raise. The White House has promised to veto the bill, saying that deficit reduction does not require changes to the Constitution, and that the cuts involved are draconian.
*The Committee for a Responsible Federal Budget’s comprehensive primer on the debt ceiling.
*The Congressional Budget Office’s report on “Federal Debt and Interest Costs.”
*The Government Accounting Office’s report on past efforts to manage delays in lifting the debt ceiling.
*The Bipartisan Policy Center’s analysis of what will happen if we pass the Aug. 2 deadline without lifting the debt ceiling.
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